Inflation is below target. Increasing output and decreasing or stagnant inflation is an indication that inflation expectations are becoming unanchored. That’s bad. Inflation should not spend too long, too far from its implicit target of 2%.

Structural unemployment is high right now. Instead of just dumbly extending UI benefits and scratching our heads on why unemployment among the young is increasing after three subsequent increases in the real minimum wage, we should do something about it.

Politically — I’m only guessing because I’m no expert — dealing with structural unemployment would be cheaper. The Fed, more than anyone else, knows how to increase inflation and they have figured out the cheapest way to do it. You might think, however, there are personnel issues at the Fed, i.e. too many hawks, that make “doing the right thing” impossible. And so, you might think, political pressure would have an effect on policy in the short run. I’m not sure why you think that. The FOMC meets only ever so often and they never take radically new action one way or the other. Policy stickiness is one of the most reliable facts about Fed policy. According to Goodfriend and King, even Volcker’s radical disinflation started over a year after he became chairman (and it took another 1/2 year to start to see employment effects). BTW, we’re not changing the chairman for a long while and even supposing Bernanke was suddenly reborn a Sumnerian, how do you think employers would react if the Fed announced bold action one way or the other? Ditto for massive institutional changes at the Fed.

In any case, with the Bernanke Put getting close to its strike price, the monetary policy car is going in the right direction. Given the current institutional framework, political pressure is not going to speed the car up.

But we can do more about structural unemployment. All it would take is for some enterprising think-tank researcher to buddy up with a promising young politician ((I’m thinking there may be an “only Nixon can go to China” effect here, but I’m sure a charming Democrat could pull it off too)) and to come up with a bold plan to deal with it. Radical changes to the UI system. Radical policies to deal with labor immobility. Radical interventions in the housing market. If engineered and sold to help reduce unemployment and as a package deal, these policies would be supported by both sides.

PS – We shouldn’t look to Europe for examples for good labor market institutions… the EU’s unemployment rate is higher than the US’s right now.

25 Responses to “Increase inflation AND combat structural issues”

It would be helpful if you could name the 15 Senators who would support cramdown/short-selling/mortgage-resets/right-to-rent/campaign-to-legitimize-strategic-defaults/etc. or other “radical interventions in the housing market” that didn’t support the cramdown vote a year and a half a ago.

Cramdown being, quite frankly, a small conservative-friendly bankruptcy judge focused approach to the situation – neither bold or radical, and the least bold/radical of the plans people have put forward on the underwater-problem over the past two years couldn’t clear 45 votes in the Senate.

I can’t think of a single Senator, and that was before Citizens United and the huge slushing of financial dollars in 2010.

It’s worth noting that the original Santelli “Tea Party Rant”, that helped stoked the grassroots conservative anger that founded the Tea Party Movement, was in response to the administration announcing HAMP, the half-assed mortgage modification program.

Anything radical enough to dislodge labor immobility stemming from housing would have to be an order of magnitude more radical than HAMP.

Tell us why cramdowns would help the labor market. Frankly, you’ve been contradictory on this point lately. Some posts you argue vigorously that the housing market is causing structural problems and then, basically, the next post you’ll talk about how its not an issue.

In any case, its not obvious whether “fixing underwater mortgages” would increase or decrease unemployment. Keeping people in their homes, however noble of an ideal that is by itself, makes the labor market less mobile.

Also, supposing cramdowns somehow magically decrease unemployment, you could sell them as a package deal with a UI overhaul.

BTW, a big part of what I’m proposing is rhetorical. One side of the isle loves redistribution, the other hates it. Both sides like efficiency. Its a no-brainer, then, to sell efficiency not redistribution. Stop talking about sticking it to the banks and start talking about how amazingly efficiency improving cramdowns are…

… if it turns out that cramdowns aren’t efficient, then, well, I guess you’re not going to be able to sell those to the other side.

1. The odds that the Fed will do some QE this fall or winter is much higher than the odds that Congress will cut the minimum wage or reform UI. You may be right that it’s hard to pressure the Fed. But like the Supreme Court they do pay some attention to elite opinion, and thus pressure can have a marginal effect. (BTW, I don’t consider myself “elite,” but some elite people do look at my blog on occasion.)

2. More AD will speed up the day when Congress reduces UI below 99 weeks, and it will slightly reduce the real minimum wage. Thus more AD will reduce structural unemployment.

3. Europe is not a good model, as you say, but there may be some things we can learn from individual European countries. Some of the smaller ones have fairly flexible labor markets, and low unemployment.

I’m contradictory in the sense that I don’t think we have a good estimate; I think it’s there to a degree and I think 1.25% is too high (do you think it is?). It’s also not clear if what people like the IMF are finding when they look at this is state budgets, demand or an externality of foreclosed properties in a neighborhood killing the local housing market.

But now I have no idea what you are getting at: “Radical policies to deal with labor immobility. Radical interventions in the housing market.” What does this mean, especially re: housing? Were you alluding to any of the policies I brought up? What are you getting at if it isn’t to stop foreclosures and give people the ability to sell their property at market prices? Is it just rhetoric stuff?

Where have I said anything about “sticking it to the banks”? I think bankruptcy law is flawed in their treatment of mortgage liens, and as a professional financial engineer I doubt the valuation of second-liens as conducted by the stress test. And what do you mean by efficient in this context?

Thanks professor. I agree that Europe isn’t one big amalgam but similarly California’s policy probably shouldn’t look like New York’s. On the connections between structural and demand policy, its possible that improvements in structural policy would have the opposite effect on the Fed… they’ll feel less pressure to act. Maybe this asymmetry is driving all the heat on this issue.

Mike, policies that encourage home ownership, if they are effective at their stated goal, keep owners in their homes and make the labor market less flexible. Encouraging foreclosures (or not discouraging them) and removing the mortgage tax credits would decrease geographic mismatch by getting people to move. This would be very traumatic for these families, I’m sure. This is why this policy could be packaged with an incentive to move… tax credits or just cut checks for families that relocate.

While I’m at it, make UI a real insurance program, beef up EITC and expand the student loan program to everybody.

On the issue of cramdowns specifically, here’s what I’m asking: why isn’t this just a pure transfer from bank owners to under water home owners? Would forced cramdowns be an improvement in terms of the allocation of resources? Would unemployment, for example, be lower if bank owners are less wealthy and home-owners more wealthy? In Pareto terms, would the pain caused to bank owners be more than matched by the gain by underwater home owners (assuming no impact on everyone else)?

Also, cramdowns wouldn’t fundamentally change the balance of power between borrowers and lenders. Banks would get more strict about lending and push for changes in institutions that favor them over home owners (e.g. bye-bye no recourse loans). In a dynamic sense, then, we’re spending a lot of political capital just rearranging the deck chairs.

I’m a bit confused here. I thought Levitin et al were arguing for cramdown because there are too many foreclosures (there are neighbourhood spillovers from foreclosure and hence wealth effects). Also, lenders (i.e. the holders of mortgage securities) have collective action problems (related to securitization) preventing them from negotiating with homeowners to reduce the debt to market prices. So we get a classic Myers (1977) debt overhang inefficiency. Also I thought the politics of this was that servicers were the ones stopping cramdown.

I’d need to see this argument laid out see what’s going on, but its relevance to the labor market isn’t obvious. I’m far from an expert on this: in the Myers 1977 analysis why doesn’t bankruptcy/foreclosure solve the problem of underwater (insolvent) home owners? (To be honest, I don’t even see the relevance of that analysis. Cramdowns are about who suffers not whether or not there’s suffering.)

Regarding collective action problems: so this hurts banks because write-downs would be better for them than being saddled with empty properties. So what? Stick it to the banks! In general, collective action problems are only a problem for the rest of us if there’s externalities.

On externalities: I have a hard time seeing the neighborhood spillover effect being empirically important once it has been separately identified from “normal” geographical correlation of house prices, i.e. how do I know if the value of my house declines because my neighbor foreclosed or because housing demand fell in my neighborhood generally?

In any case, the status quo (2, 3, 4 years on) has home owners trickling into foreclosure and stabilizing house prices.

BTW, I have no prior on whether or not cramdowns are a good idea, I just haven’t seen a compelling case for forcing them on everybody. I do have the prior that any policy that has the effect of keeping people in their homes has a negative effect on the labor market.

I have no view on the labor market. Your question was why this was not a “pure transfer from bank owners to under water home owners”. I don’t remember the details, but Adam Levitin and Michelle White have written about this at length. And, I’m sure Mike Konczal understands this better than I do. Also, the cramdown wouldn’t be forced on everybody, but only those choosing the costly route of a bankruptcy filing.

I’m not sure that the inability to empirically identify geographic externalities means they aren’t there. I think there could be pecuniary externalities on neighbourhoods and local tax bases; and stuff like blight and crime. But, it’s an empirical question.

Myers(1977) says that firms might not undertake new positive NPV projects because new borrowing would go to paying off existing creditors (“debt overhang”). So then the question is why not Pareto-improving renegotiation to get the debt down so that the project goes ahead? Well, in our case, overly rigid contracts (from securitization) with resulting diverse, dispersed creditors with different claims on different tranches, principal, interest etc. I mean, they were designed to be impossible to renegotiate. Commercial banks, which are typically the loan servicers are said to have perverse incentives. I remember a Geanakopolos and Koniak NYT op ed where they talk about servicer incentives along the lines that servicer payment schemes work such that a defaulting homeowner requires the servicer to advance the borrower’s monthly payments to the bondholder in lieu, so that the servicer wants to foreclose rather than modify. And we all suffer because positive npv projects don’t happen. This is the zombie thing. So I think the argument is maybe best stated not in terms of too many foreclosures (thought there have been a lot) but about this extend and pretend which lets servicers manage their balance sheets. I need to think about this more to be honest.

I think the essential point is that there are externalities on non-contracting parties. In terms of pecuniary externalities, and by way of historical analogy, you can think about the striking by Congress under Roosevelt of the gold indexation clause. Kroszner as a paper where he shows that the debt relief this implied resulted even in the increase in the price of corporate bonds containing gold clauses.

But bankruptcy gets you around the renegotiation problem. If the banks won’t negotiate then the bankruptcy courts will help them do so. Also, where’s the inefficiency in extending and pretending?

Yes, Mike, explain this all to us! I want to know what problem cramdowns solve. Do they avoid foreclosures and that’s the aim in and of itself? It should be obvious that avoiding foreclosures doesn’t have to be the “best” policy if you define best as most efficient or in terms of redistribution. If your aim is efficiency than it would be nice to have evidence of the size of the spillover effect. My prior is that the causal effect is small.

Bankruptcy can’t currently renegotiate the terms of first-liens in the sense that I think you think it can. Banks aren’t letting people short-sell which is the other option if people want to move out of an underwater home without walking away. If a person is underwater and wants to leave their home to move to a new job, what can they do?

If you are really interested in this, I’d recommend starting with Levitin’s “Resolving The Foreclosure Crisis: Modification of Mortgages in Bankruptcy.”

You’re right, I didn’t know that. But walking away solves the problem that bankruptcy doesn’t. I don’t see where the inefficiency (“deadweight” to use Levitin’s term) is…

In the labor market: making it *less* likely that the family will leave the house (via e.g. mortgage modifications) won’t make it *more* likely for the family to move where the jobs are. Modifications reduce labor mobility.

(PS. I read that paper but it wasn’t obvious why we want to solve the foreclosure crisis… which is exactly the question I’ve had for you. I know its obvious that we want to help people in need, but it not obvious that this is the channel through which we should do so.

Here’s a specific question for you: Levitin says “homeowners … are losing their homes in foreclosure, thereby creating significant economic and social deadweight costs”. What are these deadweight costs? Has anyone quantified them?)

Well the classic story is in Bolton and Rosenthal (2002). I tried, quite badly, to get into this with the debt overhang story (reinterpreted with households in place of ‘firms’). Then there could be pecuniary externalities on neighbourhoods and local tax bases; and stuff like blight and crime. The idea is that the house is worth more not foreclosed (sold short, or with the original owner in it after cramdown). And so for the neighbourhood, and the RMBS on which those mortgages are based. The investors should get a better payout if the servicer doesn’t just foreclose inefficiently (which he is incentivized to for various institutional reasons). At least this is my (likely incorrect) understanding of this.

Shorter version: The basic inefficiency is contractual incompleteness between the investors and the homeowners – they did not contract on this big macro shock). Ex post they would renegotiate, but for the institutional/political hurdles and common agency problems. Excess foreclosure and spillovers on non-contracting parties (on credit markets, neigbourhoods etc). Quantification is of course hard.

Contract inefficiency is an ex-ante problem, i.e. we should complete those markets. They implies that there are too few mortgages written. It does not mean that something should be done ex-post about the mortgages that were written. The problem here is with the unwritten mortgages.

Regarding pecuniary externalities… for every seller (bank) that sells at a too low price there’s a buyer that buys at a too low price. This is just redistribution from banks to buyers. Why should the rest of care about this?

Bolton and Rosenthal (2002) is precisely about how debt moratoria can complete these contracts…

It may be optimal for lenders (who are *not* “banks”, but the holders of the RMBS) to renegotiate these contracts with borrowers to avoid inefficiencies (externalities on the rest of us) related to debt overhang and neigbourhood effects (and the effect on the credit markets – e.g. securitization is dead), and they would do so, but for the rigidities related to the securitization process (the PSAs, the servicer’s incentives, etc).

I’ve skimmed the paper. Without a clear statement of the intuition behind their result I don’t see how it applies (the first gotcha is that they assume away bankruptcy/walking away but also I think their setup would have homeowners wanting to stay in their home even at the market value… this isn’t likely since most foreclosures are being driven by the house being underwater, right?).

“In the labor market: making it *less* likely that the family will leave the house (via e.g. mortgage modifications) won’t make it *more* likely for the family to move where the jobs are. Modifications reduce labor mobility.”

I’m definitely no expert here, but I definitely did just read this entire thread because it was awesome.

In my mind, the mortgage modifications we are discussing here are basically varying forms of debt forgiveness. If they aren’t, I think they should be.

Debt is both the reason people are forced out of their homes and the reason they can’t move away. In a sense I agree with you that modifications won’t make it more likely for the family to move where the jobs are, but I have an addendum: it also won’t make them necessarily less likely; through modification people will have greater flexibility in choosing to move away. I think I might like to call that “efficient”, assuming a whole litany of things about people behaving rationally.

Again, even if the jobs are still local to the people, debt could force them out of their homes. It’s basically a lose-lose situation – how people lose just depends on the community.

Debt forgiveness basically amounts to a transfer from banks to individuals, but hey that’s just ex ante on the part of the banks (they should have written more mortgages?) and I’m sure anybody who subsequently had their mortgage canceled would be less sanguine about their “transfer” than we are.

Honestly, it seems like this debate is suffering from some pretty classic maladies. First, I would say the issues are too local to stand up under very aggregated analysis (thus it seems like debt does contrary things) – I’ve spent time modeling housing markets and every indication I’ve seen points to uniquely individual housing markets being no more than a few dozen miles in diameter, with wide variance in model specification and coefficients. Secondly, it also seems like drilling down to details is forcing reductionist statements, to the point of a priori. And, I don’t mean to harp, but this seems to beg the question:

“Regarding pecuniary externalities… for every seller (bank) that sells at a too low price there’s a buyer that buys at a too low price. This is just redistribution from banks to buyers. Why should the rest of care about this?”

And the question at the end is the starting point for Laurence.

Again, I’m not terribly knowledge about the specifics – but I love the intensity of the discussion!

Not to sidetrack from your comments, but I’ve been wanting to make this comment all day but my stupid dissertation was getting in my way: I think I know what I was thinking when I wrote that last bit in the parenthetical. The Bolton and Rosenthal setup has farmers wanting to stay on their land but they can’t make the debt payments so they get kicked off. I don’t think this applies to underwater homes. These home owners DON’T want to stay in their house if it means they have to pay the book value. Anyway, if their setup is modified to deal with the current crisis (you have a dissertation topic yet Laurence? I think it would have to deal with the fact that the prices of homes, which reflect their expected future productivity, went down not that the homes have had a temporary shock to their productivity as is the case with farms in the B/R setup.